Chapter 2 Flashcards
Tax free NS&I products
Premium bonds
Direct ISA
Junior ISA
Fixed-interest savings certificates*
Index linked savings certificates*
Children’s bond*
what are fixed interest savings certificates
Historic tax-free product
lump sum investment with a guaranteed fixed rate over a set term,
index-linked savings certificates
historic tax-free product
returns are linked to RPI, or CPI
Investors with maturing certificates can reinvest the full value of their existing investment at its maturity, on the terms available at the time.
what are children’s bonds
- Historic tax-free product
- bought by relatives.
- between £25 and £3,000 per issue.
- Rolling 5-year contract that terminates on the first 5th anniversary after the child’s 16th birthday.
-These can no longer be renewed on expiry.
Taxable NS&I products
- direct saver
- green savings bonds
- investment account
- income bonds
- guaranteed income
- guaranteed growth
what is a Direct Saver
- Online or phone savings account
- pays out gross annual interest.
- Minimum £1 and maximum £2,000,000 per person.
- No additional contributions.
- No withdrawal penalties apply.
what are green savings bonds?
- Fixed term (currently 3 years),
- fixed rate.
- Minimum £100
- Maximum £100,000
- No withdrawals pre-maturity
- contribute towards government-selected ‘green’ projects.
what is an investment account
- postal-only account
- monthly interest gross
- no set term.
- Minimum £20
- Maximum £1,000,000
- Not actively promoted on the NS&I website
what are income bonds
- Variable return,
- monthly gross income gross
- no set term.
- Minimum £500
- Maximum £1,000,000
- Interest paid on 5th each month
what are guaranteed income bonds
- Guaranteed monthly income distributed gross each month
- fixed rate
- one-year or three-year term.
- Minimum £500 per issue
- Maximum £1,000,000 per issue
- No early withdrawals allowed.
what are Guaranteed Growth Bonds
- Guaranteed growth
- fixed rate over a one-year / three-year term.
- Minimum £500 per issue
- Maximum £1,000,000 per issue
- Interest paid gross at end of term
- if take out or renew bond, won’t have access until end of term
what are treasury bills
• Probably the most common arrangement.
• Mangaged by the Debt Management Office (DMO).
• Weekly auctions are held to issue the bills.
• They are bought below face value and repaid at face value to provide the growth.
• Risk-free investments.
• Over short terms (max 12 months).
what are certificates of deposit
- Fixed-term usually 1-3 months
- Interest paid on maturity
- Cannot withdraw early
- Can sell on stock market
- Interest returns fixed
- Interest linked to SONIA
- Returns generally higher than Treasury Bills.
- No guarantees apply.
- Issued by banks
what are commercial bills
• Typically very short term. 30 - 90 days is common.
• Operate similarly to Treasury Bills.
• They are bought below face value and sold at face value.
• They are not as easy to sell as Treasury Bonds.
• Often pay the highest return to mirror the highest risk.
what are standard money market funds
- fluctuating NAV
- ‘Weighted average maturity’ of no more than 6 months
- ‘Weighted average life’ of no more than 12 months
what are short term money market funds
‘Weighted average maturity’ of no more than 60 days
‘Weighted average life’ of no more than 120 days
stable NAV
Holding period return
D + V1 - V0 / V0
Effective annual rate
((1 + r/n)n - 1) x 100
Annualised return formula
(1+return)1/n - 1
Real rate of return formula
1 + nominal rate / 1 + inflation rate - 1
Interest yield
coupon x 100 / clean price
what are investment / sub-investment grade bonds
Investment grade bonds:
o Anything higher than BBB- from Standard & Poor’s, or Baa from Moody’s, are considered to have an extremely low risk of default.
• Sub-Investment grade bonds:
o These are below the above thresholds and therefore considered to have a significantly
higher risk of default.
o These are often termed as ‘junk bonds’ or high-yield bonds
modified duration formula
macauley’s duration / (1+ gross redemption yield)
Describe the characteristics of a UK corporate bond (6 marks)
• Issued by companies.
• At least one year duration at issue.
• Listed on exchanges / tradeable.
• Pay a regular coupon (income).
• Repayment of par value at maturity.
• Will have a risk or credit rating.
• Taxable to income tax
• If directly held no liability to CGT, nor allowance for any losses.
Explain briefly what is meant by default risk in relation to corporate bonds (3 marks)
• Default risk is the risk of the bond not being redeemed
• or the company missing a coupon payment
• on the due dates.
List four risks, other than default risk, that may apply to UK corporate bonds (4 marks)
• Interest rate risk.
• Liquidity risk.
• Inflation risk.
• Tax change risk.
• Credit risk
Describe how redemption yield differs from interest yield (3 marks)
• Redemption yield is a more accurate calculation of the true rate of return from a bond.
• It takes into account all the cashflows from the bond including capital repayments.
• It also makes adjustments for the time taken until each cashflow is received.
Explain what is meant by ‘duration’ for a corporate bond investment (5 marks)
• Measure of price sensitivity to changes in interest rates.
• Expressed as time period.
• Measured in years.
• Taking account of all cashflows including coupons and return of capital.
• For capital / initial investment to be returned.
Explain briefly what is meant by the term ‘accrued interest’ and how this is treated in the purchase amount
• Interest earned.
• From the last coupon date up to the date of purchase.
• It would be added to the purchase price of the bond.
what is offers for sale
Offers for sale
o Shares are marketed to the general public, with the share price set lower than optimum to
encourage demand.
o The price can be:
▪ fixed upfront, usually for large stable companies such as with privatisations.
▪ determined via a tender process where bids are obtained before the share price is set.
▪ offers for subscription which is a kind of tender process but with no commitment to go
ahead with the issue if the demand isn’t high enough
what are placings?
Placings
o A cheap and fast way to get shares to market, often used by smaller companies
o It is a ‘pitch’ directly to big institutions, such as investment banks or pension funds, to buy the shares.
o As the general public aren’t involved, there are no expensive marketing or printing of detailed prospectuses involved.
what is a rights issue
- it’s an offer for sale, but the existing shareholders are at the front of the queue. They get the option to buy the shares first; additional shares are offered to them in proportion to their existing shareholding.
- The subscription price is always pitched below the current market price, this
discount makes the offer attractive, and the company most likely to raise the
required funds. - By issuing more shares at a lower price, this will affect the overall share price post issue.
what is a bonus issue?
- Bonus issues are where a company issues new shares, paying for them out of their reserves. This is sometimes known as a scrip issue. This effectively dilutes the existing market price of a share, making it
more attractive to investors. It can also change the proportion of the company owned by existing
shareholders.
what is a share split
A share split is where shares in issue are split into a greater number of shares, each with a smaller nominal value.
What is EPS used for
- Shows trend in profitability
- All companies list their EPS.
- Shows the amount per share, in pence, that the company has earned during the year.
- Widely used to make comparisons from year to year and with other companies.
- Best looked at as a trend over time.
What is EPS formula
profit after tax and preference dividends / number of ordinary shares
what is dividend yield used for
Shows the true value of a share’s dividend
• Result shown as a percentage.
• Yields fluctuate with share price.
• Unreliable in forecasting future returns.
• A low dividend yield may indicate an overvalued share.
• A high yield may indicate low growth or that it is underrated by the market.
dividend yield formula
dividend per share / current share price x 100
what is dividend cover
Shows how many times the dividend could be paid out of available current earnings
• The higher the figure, the better.
• A high figure, e.g. ‘10 x’, shows that profits are being retained rather than shared.
• The higher the dividend cover, the less likely it is that a company will have to reduce dividends if profits fall.
dividend cover formula
EPS / dividend per share
P/E ratio use
- compares companies in same sector
- relationship between share price and earnings
- meaningless on its own, better for comparing companies or time periods
- measures how highly investors value company and its ability to grow income stream
- higher P/E ratio, the more the shares are in demand, and the more the earnings are expected to grow.
P/E formula
share price / EPS
PEG uses
Establishes whether a company’s P/E ratio is justified
• A number of less than 1 would indicate that the shares are potentially attractive.
PEG formula
P/E ratio / estimate of companies average earnings growth for next 5 years
Use of NAV formula
Shows the amount available to shareholders if the company were to close down, sell all its assets and distribute the balance
• The value of the tangible assets attributable to ordinary shareholders.
• Often used to price collective investment schemes and
show the minimum value that the shares would be
worth on wind-up of the company / collective.
NAV formula
net assets attributable to ordinary shareholders / number of ordinary shares in issue
Price to book ratio use
Measures the relationship between the company’s share price and the net book or asset value per share attributable to its ordinary shareholders
• If ratio shows share price is lower than its book value, this can indicate that it is undervalued, or that market perceives that it will remain a stagnant investment.
• If share price is higher than book value, this
suggests investors view it as a company which has above-average growth potential
PB formula
share price / NAV
Use of Gordon’s growth model to calculate share price
A simplified model for calculating a share price.
• Assumes constant dividend growth, and dividend payments made at the end of each period.
• Helps place a price on the value of an ordinary share.
• Simplistic, and only suitable for mature
shareholdings with track records.
• Crude and simplistic formula.
• Can give an idea on the current share price against future expected growth.
Gordon’s growth Model to calculate share
price formula
dividend / (return required - dividend growth)
Limits of ratios
- Different accounting procedures can apply, which can make the figures unreliable.
- If the company has altered its share capital, for example via share splits or share consolidations, this can alter these
ratios. - They often use historical data, sometimes over a year out of date.
- The ratios are only as good as the source of information used, financial statements can contain subjective elements, which can distort the calculations.
- The impact of inflation, interest rates, and taxation may be different year on year.
- Often, they are useless on their own and need to be compared to a similar business or over different time periods.
- Ratios shouldn’t be used in isolation. They provide only part of the story, and often riase more questions than answers.
- Other factors would need to be considered.
Risks associated with property investment
• Liquidity Risk: the ability to sell at a given time or realise cash quickly.
• Management Risk: skills and funds required to run the business.
• Void Risk: the risk that the property will be vacant.
RAR relief criteria
- must be owners main residence
- one exempt amount per residence
- must not be self-contained
- must be furnished
- owner must also be resident
- must be in the UK
Commodity general characteristics
- can provide diversification
- may not be correlated with existing investments
- does not provide income
- returns often exceed inflation
- commodities high risk / more volatile
what is cryptocurrency
• Each investor has a unique ‘blockchain’ which identifies them as an investor.
• No formal logging of ownership is taken; each investor simply has their own
password and unique log in. This has led to accusations of them being a tool that
can be easily used for money laundering.
• Currency is often purchased via an online website such as CoinCorner and paid for
by a credit card.
• Once confirmed or mined, you instantly own part of that currency.
• The currency purchased is electronic and not influenced by any bank or
government.
• These investments have proved volatile with often huge sways of gains and losses
being evident, they are also unregulated, so not for the faint-hearted.
